Death Cross For S&P 500 And Russell 2000 Taking Place

Aug.12.14 | About: SPDR S&P (SPY)

Summary

Monthly momentum indicators are bearish on the S&P 500 and Russell 2000 for the first time since 2011.

The last bearish phases in monthly MAC-D's were 2011, 2007, and 1999.

Rich valuations, and a tense macro environment provide fundamental basis.

More substantial shifts in the technical underpinnings of the post 2009 market rally imply that this current sell off is different from previous buyable dips. The last bearish phases in monthly MAC-D's were 2011, 2007, and 1999. All of these occurrences resulted in high volatility (VIX>40) and a sell-off of at least 19% on broad market indices. As a result, the likelihood of an extended sell off in the S&P 500 (NYSEARCA:SPY) and Russell 2000 (NYSEARCA:IWM) is high.

The fundamentals behind current stock prices have been unjustified for a while. So, what is the catalyst that will provide a meaningful excuse for market participants to sell? Overvaluation alone is not enough to prevent animal spirits, so these are our hypotheses about what can turn a minor correction into a bear market sell off. Geopolitical tension is at the highest level in over twenty five years, however, history tells us that the market risks of geopolitical conflicts is more concentrated on individual countries, stocks, or commodities (example: Wheat and Moscow index on Ukraine news), and do not sink global markets as a whole. Earnings have been lackluster since early 2013, but multiple expansion has increased by over 33% over the same period. Tapering has also been present since December, and by October, the Fed will no longer be a net buyer of bonds.

I think it will ultimately be a combination of these things, but I think the market will simply run out of buyers as rates rise. As inflation expectations have risen with asset prices and geopolitical factors, investors will sell off bonds. In addition, the lack of further easing will provide no impediment to the market driving rates upwards. Rising rates will reduce the profitability of marginal investment choices that will cause defaults or low risk adjusted returns that eliminate the justification to buy at current valuations.

Disclosure: The author is short SPY, IWM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.